Five-and-Five Power in a Trust

A five-and-five power is a withdrawal right that allows a trust beneficiary to withdraw up to the greater of 5% of the trust’s assets or $5,000 each calendar year without triggering income or gift taxes on the trustee or the trust creator. It’s a clever estate-planning tool that blends creditor protection (assets stay in trust) with gifting flexibility (the beneficiary can access a meaningful slice annually).

The mechanics of the power

A five-and-five power is a clause written into a trust document that explicitly grants a named beneficiary the right to withdraw funds during each calendar year. The withdrawal limit resets annually on January 1st and is calculated as whichever is larger: 5% of the trust’s net asset value on a specified date (often the last day of the prior year), or $5,000 in fixed cash.

Example: A trust holds $200,000 in assets on December 31st. Five percent of $200,000 is $10,000. The beneficiary can withdraw up to $10,000 during the following calendar year (January 1 through December 31). If the trust only held $80,000, 5% would be $4,000, which is less than $5,000, so the beneficiary could still withdraw $5,000.

The beneficiary doesn’t have to exercise the power. If they choose not to withdraw, the power “lapses” (expires) on December 31, and any unused amount simply stays in the trust for the next year. This lapse is the crucial feature that makes the power valuable for both asset protection and tax planning.

Why a settlor would create this power

From the settlor’s (trust creator’s) perspective, a five-and-five power serves several goals:

Flexibility for the beneficiary. Rather than locking assets away entirely until the beneficiary reaches a certain age or the trust terminates, the power gives ongoing access to a meaningful annual slice. A beneficiary facing medical expenses, education costs, or temporary cash flow problems can tap the trust without asking a trustee’s permission.

Creditor protection for the beneficiary. Assets unused within the power remain in the trust and maintain spendthrift protection if the trust includes a spendthrift clause. If a beneficiary gets sued and has $50,000 in the trust but only withdraws $5,000 that year, $45,000 stays protected in the trust.

Estate and gift-tax efficiency. Because the power is discretionary (the beneficiary can choose not to use it), lapsed amounts escape being included in the beneficiary’s estate. This allows a settlor to gift assets into the trust without depleting their lifetime gift-tax exemption year after year.

The gift-tax mechanics and the lapse rule

This is where the tax code and trust law intersect in a nuanced way. When a settlor creates a trust and funds it with assets, that funding is generally a gift. Without special language, the entire gift would count against the settlor’s annual exclusion (currently $18,000 per beneficiary per year as of 2024, but indexed annually) and potentially against their lifetime exemption.

A five-and-five power circumvents this limitation. Under Section 2514(e) of the tax code, if a beneficiary lapses (chooses not to use) the power during the year, the lapsed amount is treated as a taxable gift—but only to the extent it exceeds both $5,000 and 5% of the trust’s principal value. Because lapsed amounts within the 5% and $5,000 threshold escape the gift-tax rules entirely, the settlor can fund a much larger trust and still keep the annual exclusion intact.

Example: A settlor creates a trust with $200,000 and funds a five-and-five power. The beneficiary can withdraw $10,000 (5% of $200,000). If the beneficiary doesn’t withdraw, the $10,000 lapse doesn’t trigger a gift tax because it’s within the 5% limit. But if the trust held $1,000,000, the 5% withdrawal right would be $50,000, and any lapse over $5,000 would create a gift-tax issue—the excess $45,000 would be treated as a taxable transfer.

How five-and-five powers interact with estate planning

A five-and-five power is often paired with a spendthrift trust or a discretionary trust. The beneficiary enjoys some certainty of access (the power), but the underlying trust assets remain protected from creditors and controlled by a trustee who can still exercise judgment on distributions above the five-and-five threshold.

In blended-family situations, a settlor might create a trust with a five-and-five power for a spouse and a different distribution schedule for children, ensuring the spouse has annual access while preserving principal for the next generation.

In medicaid-lookback-period planning, a five-and-five power generally does not count as a “countable asset” for Medicaid purposes if the power hasn’t been exercised. Once the beneficiary withdraws funds, they become personal property and may affect Medicaid eligibility.

Unused powers and lapse events

One trap: if a beneficiary’s five-and-five power goes unused and the trust document doesn’t explicitly address what happens to the lapsed amount, the tax code’s default rule kicks in. Section 2514(e) treats the lapse as a taxable gift to the extent it exceeds the greater of $5,000 or 5% of principal. A well-drafted trust document clarifies that lapsed amounts simply stay in trust, making the lapse harmless for tax purposes.

If the trust document is silent and a large power lapses, the IRS might assess gift taxes on the lapsed amount, and the beneficiary (or their estate) could face unexpected tax liability years later. This is why the boilerplate language matters: “Any withdrawal right not exercised by December 31 shall lapse and shall not be cumulative.”

Crummey powers and alternatives

A related concept is the “Crummey power,” named after a landmark tax case. A Crummey power is a limited withdrawal right (typically 30 days per year) that allows a beneficiary to withdraw current contributions to an irrevocable trust. Unlike a five-and-five power, which resets annually and is ongoing, a Crummey power is usually tied to specific contributions and lapses when the withdrawal window closes.

Crummey powers serve a similar gift-tax function: they allow a settlor to fund a large trust while treating contributions as gifts of “present interest” (which qualify for the annual exclusion) rather than gifts of “future interest” (which don’t). A five-and-five power operates differently—it doesn’t require an explicit trigger or withdrawal window; instead, the beneficiary simply has a standing right to pull 5% or $5,000 each year.

Distributions above the power

If a trustee distributes amounts above the five-and-five power (or if the beneficiary wants more), those distributions come from the trustee’s discretionary authority, not the power itself. A trust might state: “The trustee may distribute to the beneficiary such amounts as the trustee deems appropriate, in addition to the beneficiary’s five-and-five power.” This keeps the two rights conceptually separate and ensures clarity on what is governed by the power (guaranteed, automatic, taxed under lapse rules) versus what is discretionary.

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